Valid Worries About the Cost of Easy Money

The Bundesbank, the German central bank, is not crazy. In a world where it is increasingly fashionable to call for central banks to print money, the Bundesbank is one of the last bastions of orthodoxy. Although its stance is extreme, it is a useful antidote to the theory that easy money is a cost-free cure for economic ills.

The bank is hostile to anything that smacks of monetary financing — printing money to finance governments’ deficits. It is worried that central bank independence is getting chipped away as economic weakness drags on in much of the developed world; it thinks that the European Central Bank should not respond to the recent rise in the euro by loosening monetary policy further; it is always concerned about the potential for inflation; and it thinks that spraying cheap money around can allow governments to shirk their responsibilities.

To many people, these attitudes seem old-fashioned. Surely central banks should bend the rules to get the world economy out of its current rut, they say. A few go even further and advocate “overt monetary financing”, as Lord Turner, chairman of the British Financial Services Authority, did in a seminal speech earlier this month.

Mr. Turner made it clear that this was a policy that should be reserved for the most intractable deflationary recessions, the ones in which monetary policy cannot work (because businesses and households are already so clogged up with debt that they do not want to borrow more) and fiscal policy cannot do the trick either (because governments are over-indebted, too). While he advocated the medicine for Japan, he was wary about giving it to Britain, the euro zone or the United States.

The European Central Bank, it should be added, is not engaging in overt monetary financing. That is forbidden under the Maastricht Treaty, which led to the euro. But it is arguably engaging in the covert variety. This is the source of most of the friction between Mario Draghi, president of the European Central Bank, and Jens Weidmann, the Bundesbank boss — both of whom are based in Frankfurt.

The biggest clash was over Mr. Draghi’s promise last year to buy potentially unlimited amounts of government bonds from peripheral euro zone countries. Mr. Weidmann unsuccessfully opposed the plan. Mr. Draghi was right. If he had not pledged to do “whatever it takes” to save the euro, the single currency might well have collapsed.

That said, all such operations have a cost. Mr. Draghi’s drug may have taken some of the pressure off governments to make their economies more competitive.

Mr. Weidmann and Mr. Draghi clashed again this month over the Irish “bailout” by its central bank. The extremely complex transaction involved the Irish central bank’s receiving €25 billion, or about $33.5 billion, worth of extremely long-term Irish government bonds after IBRC, a nationalized bank, was liquidated. Dublin did not itself have the cash to fill the hole in IBRC’s balance sheet. It has effectively borrowed the money, equivalent to 15 percent of the Irish gross domestic product, cheaply from its central bank.

Mr. Weidmann would have preferred that euro zone governments lend Dublin the money via their bailout fund, the European Stability Mechanism. But other governments were not rushing to provide the cash and Dublin was not eager to use it either, as the interest rate would have been higher than issuing bonds to its central bank.

Although the Irish bailout was a deal between Dublin and its central bank, the European Central Bank could have blocked it. But to do so, two-thirds of its governing council would have had to vote against the operation — and Mr. Weidmann did not have enough support.

Mr. Draghi, meanwhile, did not actually back the deal. He merely “noted” it. The European Central Bank concluded that the new arrangements for supporting IBRC were preferable to the previous program — which many observers also thought amounted to monetary financing.

As with Mr. Draghi’s bond-purchasing promise, the effect has been hugely positive. Irish 10-year government bond yields are now 3.7 percent. Investors now view the country as on the road to recovery.

But the Bundesbank is, understandably, worried about precedents. The next time a bank gets into trouble in the euro zone, what is to stop a government from bailing it out the Irish way — by getting its central bank or the European Central Bank itself to print the necessary money?

The pressure to engage in such monetary financing may be particularly strong, given that the European Central Bank is about to take over responsibility for supervising lenders. That means that if and when there are future banking blowups, the European Central Bank will be criticized for having failed to monitor them properly and could then be browbeaten to prop them up. The Irish, Spanish and Dutch central banks have all been accused of lapses in supervision during the crisis — as, indeed, has Mr. Draghi himself following the recent troubles at Monte dei Paschi di Siena, an Italian bank.

A further difficulty is that the euro zone does not yet have a fund for bailing out banks. The nearest thing it has is the stability mechanism, whose decisions require unanimity. Just one government can veto a bailout. This means that if there is a standoff between the European Central Bank and governments over who should prop up an ailing bank, the European Central Bank may blink first.

Covert monetary financing may sometimes be the least of several evils. But if it becomes too common and transparent, there is a risk of debauching the currency.

The Bundesbank’s constant warnings are a healthy counterpoint to that temptation.